Trial run for cap and trade auction

SAN FRANCISCO – Come November, California will open North America’s first full-scale carbon market, in which companies buy and sell the right to emit greenhouse gases from their factories, power plants and oil refineries.

It’s a major undertaking involving hundreds of companies and — potentially — billions of dollars. So on Thursday, California officials plan to stage a dress rehearsal.

The California Air Resources Board will hold a practice auction, giving future players in the carbon market a chance to see how the process works in real time. The board, which has spent years developing the market’s rules and mechanisms, will have a chance to test their handiwork before the first real auction, on Nov. 14. Starting in 2013, auctions will be held four times per a year.

“We think we’re in pretty good shape, but this will give everyone a chance to see how it’s working,” said Dave Clegern, spokesman for the board.

But the trial run, held over an electronic exchange, won’t answer the larger questions surrounding “cap and trade.”

Carbon markets are designed to cut emissions of carbon dioxide and other greenhouse gases over time at the lowest possible price. Government officials set an overall emissions limit, or “cap,” which declines year by year. Companies buy and sell permits — called “allowances” — to emit greenhouse gases at their facilities. Businesses that are able to slash their emissions can sell their spare allowances to other companies that are having a hard time making cuts. As the cap lowers over time, the price of the allowances goes up.

The European Union has a carbon market, created in 2005, that spans most of the continent. And in North America, a coalition of northeastern states and Canadian provinces opened a limited carbon market, in 2008, that covers only emissions from power plants.

But carbon markets are fiendishly complex, and changes in the rules can have big effects on the companies involved. California’s market will include power plants, oil refineries and factories that emit more than 25,000 tons of greenhouse gases each year.

California’s oil refiners have been pushing to have all the allowances given away for free at the start of California’s carbon market. The current rules could push some refineries — which have limited options to reduce their own emissions — toward closure in a state where gasoline costs more than $4 per gallon, they say.

“This trial auction doesn’t do anything to resolve that,” said Catherine Reheis-Boyd, president of the Western States Petroleum Association. “We really have between now and November to deal with this issue. And if they don’t deal with this issue, we don’t think they should go forward with the auction.”

Some environmentalists, meanwhile, question whether the carbon market will lower emissions as quickly as the state hopes. The market is the result of a 2006 California law that calls for cutting the state’s greenhouse gas emissions to 1990 levels by 2020.

“I’m not expecting this to be a disaster by any means — what I’m wondering about is, over the next five years, will we see any real reductions?” said Kathryn Phillips, director of Sierra Club California.

The state’s carbon market also will open in the long shadow cast by California’s electricity crisis. Manipulation of the state’s recently restructured electricity market in 2000 and 2001 helped trigger blackouts, sent power prices soaring and pushed Pacific Gas and Electric Co. — the state’s largest utility — into bankruptcy.

The Air Resources Board has spent years trying to anticipate ways that traders might similarly game the new system. As a result, the board has adopted strict limits on the number of allowances any trader or company can have, so no one can corner the market.

Most companies that are required to participate in the auctions can hold no more than 15 percent of the allowances that are available for sale. Traders can hold no more than 4 percent.

All parties that plan to trade in the allowance auctions must deposit — 12 days in advance — all of the money needed to pay for their bids, with Deutsche Bank handling the deposits. Within 48 hours after the auction, a market-monitoring company will tell the board whether any unusual trading patterns emerged that could reveal manipulation. There’s also a market surveillance committee made up of experts from Stanford University, UC Berkeley and UC Davis.

Those steps won’t deter every trader from looking for ways to exploit the market, the board acknowledges. “We figure someone will try, and we hope we’re ready,” Clegern said.

Thursday’s practice auction will take place on an electronic trading platform from 10 a.m. to 1 p.m.Companies that will be required to trade in November’s real auction don’t have to participate in Thursday’s trial run on an electronic trading platform, but about 150 are expected to do so. No actual money will change hands, and no settlement price will be publicly posted.